Petrobras woes deepen Brazil concerns

NEW YORK, Jan 9 (IFR) - Petrobras’s pariah status worsened this week as a widening corruption scandal and acceleration fears left investors fleeing the Brazilian state-controlled oil outfit’s benchmark bonds and any other credit associated with the company.

The investigation into kickbacks and corruption allegations at Petrobras - widely known as “Operation Car Wash” - has already claimed several victims, including construction firm OAS, which opted on January 2 to miss a payment on its 2021s to preserve liquidity after being temporarily banned from bidding on any future contracts with Petrobras.

Indeed, uncertainty over the scope of wrongdoing and fears of more revelations concerning corruption has the buyside taking a broader hands-off approach to Brazil, a country already struggling with deteriorating fiscal numbers and flagging growth.

“In a country like Brazil where a big portion of the economy is still linked to the government, (a scandal like this one) has an economic effect on the country as a whole,” said Maxim Vydrine, an emerging markets debt fund manager at Amundi Asset Management.

Jack Deino, head of emerging market portfolio management and senior portfolio manager at Invesco, took a similar view, saying: “If they don’t get this problem solved soon, these companies are going to stop a significant portion of their business, generating layoffs and slowing economic growth, which is already teetering.”

Distressed fund Aurelius Capital Management - better known as one of the lead holdout investors battling Argentina in US courts - exacerbated investor fears in late December when in a letter to holders of Petrobras bonds it warned that a technical default was looming after the company failed to release unaudited third-quarter results after the 90-day deadline set by some indentures.

Rumours this week that Aurelius was seeking to benefit from an acceleration after buying Petrobras CDS were enough to send the Petrobras curve reeling.

The short-end of the curve was particularly vulnerable to such talk, given the high cash price, and widened by about 100bp on Tuesday. The 2016s hit a wide of around 675bp-700bp, but traded back down to the high 500s by the end of the week.

The 2024s also suffered, trading out to a mid-market price of 567bp before returning to a mid of 511bp on Friday.

And while management was quick to nip such concerns in the bud after agreeing with creditors to release results by the end of the month, investors remain wary.

The spread on the 2024s, for example, is still considerably wider than the sub-400bp seen in November when the corruption scandal truly started to dent market sentiment.

ACCELERATION

In December, Moody’s placed Petrobras’s Baa2 rating under review for a possible downgrade, citing the possibility of acceleration and subsquent liquidity pressures if the company did not meet indenture requirements to deliver financial statements.

If Petrobras sticks to its late-January deadline, investors and rating agencies are expected to give it some leeway. But Petrobras faces other potential hurdles over the medium to longer term.

The company needs to increase production to boost Ebitda and lower leverage ratios that now stand at around five times - a level that agencies say is unsustainable if it is to avoid a downgrade. However, the recent rout in crude prices could sabotage such plans.

“You have to make a commitment that within four or five years your balance sheet will be back to around three times levered,” said Deino. “How are you going to do that? The numbers don’t add up. You have somewhere near US$40bn in annual capex but you are not generating that much Ebitda. They say the plan is to increase production, but debt is going up and oil prices are going down.”

Meanwhile, Petrobras is locked out of the capital markets - at the very least until it fulfils its obligation to publish audited 2014 results by the June 30 2015 deadline. Between now and then it will have to fall back on cashflow generation and government support, say analysts at UBS.

Indeed, it is that implicit government backing and the long-term benefits of reducing corruption costs that may ultimately lure investors back into the credit, especially if it looks cheap.

“It is a strongly supported credit. The Brazilian government will probably never let Petrobras go down. I don’t think it goes to junk, and at some level you just hold your nose and buy it,” Deino added.

“Longer-term, the investigation is positive. Some of the cost overruns (due to corruption) are massive. If they can clean it up, it would be very accretive and that goes down to the bottom line.” (Reporting by Paul Kilby; Editing by Matthew Davies)